The paper empirically studies the financing of investment under incentive problems. From the perspective of informational asymmetries among contracting parties, the firm does not behave as in the neoclassical framework. By contrast, it bears the restriction to access external funds, when information asymmetry is severe. After deriving the Q-model, the estimation strategy consists of specifying static and dynamic Q-equations and fitting them using a set of nine OECD European countries. The empirical regularities show that, even after correcting for the endogeneity problem and controlling for Tobin's Q, the investment-cash flow sensitivity does not necessarily behave according to the so-called upward monotonic behavior predicted by Fazzari et al. (1988, 1996 and 2000). The paper therefore supports the theoretical and empirical results of Kaplan and Zingales (1997 and 2000), Lyandres (2007), and Mansour (2009) casting doubt on the usefulness of the investment-cash flow sensitivity as a useful metric for financing constraints.

Corporate finance is basically the study of financial frictions and their impacts on financing/investment decisions (Hennessy and Whited, 2007). The violation of Modigliani and Miller's (1958) conjectural framework leads to the interdependence of such decisions. More particularly, once the information-driven problems enter the picture, the firm's financial resources are not priced equivalently. Hence, the external funds (either debt or equity) and net worth are not perfect substitutes (Islam, 2002). Such a prima facie, common belief is taken for granted as the major result of the financing constraints literature.

This paper deals with the role of internally generated funds in driving the firm's capital expenditures. Indeed, we borrow the approach augmenting the benchmark Q-equation in order to test for the presence of financing constraints. This approach was pioneered by Fazzari et al. (1988). It basically consists of partitioning a sample of heterogeneous firms into two or more subgroups of homogenous firms in terms of their ability to access the external funds' sources. Mainly, some criteria are chosen such that they reflect the firm's degree of financing constraints. After controlling for the future growth opportunities, the cross-sectional investment cash-flow sensitivities are compared among the formed subgroups.

Applied Economics Journal, Corporate Finance, Informational Asymmetries, Financial Resources, Financing Constraints, Empirical Methodology, Investment Projects, Dynamic Programming, Capital Investments, Capital Accumulation Ratio, Financial Frictions, Financial Variables, Capital Markets, Investment Decisions, Capital Stock Valuation.